We’re nearly nine years into the current bull market. Alex Wright, Portfolio Manager of Fidelity Special Values PLC, explains why now might be the time, against mounting pressures of higher inflation and interest rates, for value investors to start to look at which stocks offer absolute value.
We can always point to stocks which appear relatively cheap. But for real value investors, there is something unsatisfactory about making claims for ‘cheapness’ based on a comparison to another asset which may itself be expensive and over-valued. And nearly nine years into a bull market, there are certainly plenty of stocks which fit this description. With the market’s overall valuation looking vulnerable in the face of higher inflation and interest rates, I think now is a good time to look at which stocks offer absolute value, as well as being relatively cheap.
Value is always subjective, but some measures of value are more subjective than others. Valuing a company on its future earnings only works well if we can accurately forecast those earnings, and this is not always possible. On the other hand, book value is an independent assessment of what a company would be worth in the event of its liquidation. Although this measure is by no means perfect, it relies less on assumptions about the future, and is a more stable measure of value. This is why Ben Graham (often referred to as the father of value investing) advocated focusing on book value to determine the margin of safety available in an investment.
For me, if a stock trades close to or below its liquidation value, this is as good a definition of ‘absolute value’ as any other. These are unlikely to be the highest quality businesses in the market. Investors will be worried about something, and in many cases, will be right to be worried. But, in some cases the market will have over-reacted. If we can identify potential for significant positive change, then the stock will offer a very attractive balance of risk and reward.
We currently have 27 stocks, or 20% of Fidelity Special Values PLC below 1.1x book value.* This gives me confidence that despite much of the market trading at high prices compared to historical averages, there is still absolute value to be had. Below are some examples, but as ever, reference to a specific stock is not a recommendation to buy.
International Personal Finance trades below book value despite being one of the most profitable businesses I own, selling consumer credit in Eastern Europe and Emerging Markets. The shares fell dramatically in 2016 after the Polish Ministry of Justice announced plans to cap rates on consumer lending products, and the stock’s valuation reflects a worst case outcome in Poland, although this by no means inevitable.
RBS is the most recent of the UK banks I have bought for the Trust. This is another stock with a large degree of uncertainty related to a political/regulatory event. The US Department of Justice will at some point announce a fine related to the historical sale of mortgage backed securities, and although the fine will undoubtedly make for a dramatic headline, the bank has enough capital for almost any outcome. In fact, our expectation is that once the fine has been decided, the bank will be able to begin buying back shares below book value.
John Laing Group is an investor and manager of global infrastructure assets. The market appears to be valuing this company as it values infrastructure funds, hence the discount to Net Asset Value (NAV). However, we believe this is the wrong valuation approach, as it ignores the company’s proven ability to ‘compound’ growth through its origination and management activities, which funds are unable to do.
This is what the Company would be worth in the event of liquidation.
Net Asset Value
The value of an entity's assets minus the value of its liabilities.
Margin of safety
The difference between the intrinsic value of a Company and its market price.
*Source: Fidelity, as at 17 April 2018.
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